Japan has slid into recession. Between April and September, the world's third-largest economy registered successive quarters of shrinking gross domestic product (GDP). Even before the data was released, the Bank of Japan (BoJ) announced it would increase the size of its quantitative expansion (QE) programme. The announcement pushed the yen to a seven-year low against the dollar. Japan has seen low growth and deflation for 24 years. It has tried multiple QEs. Also, there has been massive deficit financing of infrastructure capacity. Government debt is a whopping 2.5 times the GDP. Shinzo Abe, prime minister, might have triggered the recession when he raised taxes in April to reduce government debt.
It is believed at two per cent levels, inflation will stimulate consumption demand; the QE is designed to target that two per cent. Economists say the recession will be short-lived and a recovery could start in the next quarter (January-March).
How does this affect India and, in a broader sense, the world? India and Japan have a comprehensive economic partnership agreement. In 2012-13, bilateral trade stood at $18-19 billion, falling to $16 billion in 2013-14, as both the rupee and the yen declined against the dollar. Since 2000, private foreign direct investment (FDI) from Japan has been $15-16 billion.
Prime Minister Narendra Modi's visit to Japan in September led to FDI commitments amounting to about $35 billion through the next five years.
As Japanese exports (to India and the world) are likely to rise due to a weaker yen, Japan could get a larger share of global trade. This might induce China, Korea, Thailand, etc, to weaken their respective currencies. Japanese FDI flows into India could fall below the estimated $35 billion, as the yen has fallen substantially and is expected to remain weak for an extended period. So long as QE continues, the yen will trend weaker. Borrowing in yen and buying risky assets in any other currency will be attractive. The yen carry trade could mean a lot of money flowing into Indian equities and other assets. There is a point at which the yen will snap back or, more likely, see many recoveries between net losses. Being net-short on the yen against any other currency might be profitable. In strictly local terms, Indian markets are valued somewhat higher than the fundamentals seem to warrant. But the consensus about future performance is optimistic. For a foreign institutional investor interested in yen carry trades, India is an obvious destination. The market is big enough to absorb large investments and has relatively high growth rates compared to peers.
Also, India is out of step with many other large economies. It could be a haven in 2015, which promises to be a year of low global GDP growth. Though the US is pulling out of recession, China, Europe and Japan remain weak, while Russia is struggling. Among other emerging markets, Indonesia is weakening amid higher inflation, while Brazil and South Africa are amid woes. India, on the other hand, has higher GDP growth and lower inflation. Though the Indian economy has many problems, 2015 could be better than the past three years. The BoJ's decision to expand QE might ensure Indian stock markets remain buoyant.
An interesting aspect is the asset allocation patterns in Japan. That country has seen zero or near-zero interest rates for a long time. Under these circumstances, conventional wisdom indicates a rise in consumption and a shift in asset allocation from debt to equity.
But Japan has an ageing workforce and a large retiree population. Household savings patterns remain debt-oriented and consumption hasn't increased. Though a stock market recovery has been seen, it has not translated into wealth effects and increased consumption. Few individuals hold substantial equity. For 20 years, the stock market headed nowhere, and this has created permanent aversion.
This has interesting implications. India has very different economic conditions, very different demographics and a very different stock market performance. But Indian household savings and asset allocation patterns seem to be as equity-averse as Japan. The underlying reasons for India being equity-averse might include lack of trust. While the stock market has given stellar returns, it has also seen periodic scams and scandals. Many retail investors lost money when they were caught in these, leading to their family/friends also turning equity-averse. It will take time before this changes.